Termination Notice Traps: How to Avoid Common Mistakes

The following situation is illustrative of what happens if the local laws are not followed. A motorcycle franchisor believed that one of its Illinois franchisees was harming its reputation and providing unsatisfactory customer service. The franchisor issued a termination notice based on the '30-day no cause language' in the franchise agreement, and it granted a new franchise to another dealer a few blocks away. Unbeknownst to the franchisor, regardless of what is in the franchise agreement, it is unlawful in Illinois to terminate a motor vehicle franchise without giving 60 days' notice. The franchisor also has the burden of establishing 'good cause' for termination. Similarly, it is generally unlawful to place another dealer within 10 miles of an existing dealer without providing 60 days' prior notice and, if the existing franchisee objects, conducting a 'good cause' hearing. Liability to the terminated dealer for not following the local law includes injunctive relief, compensatory damages, treble damages, and attorneys' fees and costs.

Avoid the Laundry List

Another common mistake is to 'over terminate' by including in the termination notice a laundry list of everything that the franchisee did wrong. The risk of using the laundry list occurs because, despite decades of legal precedent, a judge or arbitrator deciding whether a termination is proper will often begin with the 'smell test.' If some of the reasons appear to 'stink,' the judge or arbitrator is more likely to find that the termination was arbitrary. At a minimum, the taint of asserting more obscure grounds raises the probability of increased legal costs associated with defending the termination. It is easy to understand, for example, that a franchisee that has not been paying its required royalty should not be allowed to operate. It is less apparent, however, why a franchisee that used white napkins instead of branded napkins should be terminated.

Make Sure Defaults Are Really Defaults

It also is important that the reasons given for termination are based on actual defaults under the franchise agreement or the operations manuals. Too often, terminations are based on what could be considered subjective impressions that the franchisee is not following an aspect of the system, when, in reality, no such system requirement exists.

If, for example, the franchisee is being terminated for closing the franchised location on Mondays, the franchisor should make certain that the operations manuals state the franchisees must be open on Mondays. Similarly, if termination is based on monetary defaults, franchisors would be wise to check and then re-check the amounts claimed to be owed. If the franchisor miscalculated the amount, or did not provide backup for expenses charged to the franchisee, the franchisee will have ammunition to argue the termination was wrongful.

Spell Out Post-Termination Provisions

Most franchisees do not know what they are required to do upon termination. The termination notice should therefore set forth in plain English a checklist of what the franchisee must do and what will happen if any of the items on the checklist are not done in a timely manner.

It is equally important that the checklist not contain requirements contrary to the post-termination provisions in the franchise agreement. The franchisor also should consider whether to waive some post-termination remedies. For example, many franchise agreements allow for the recovery of the net present value of future royalties that would have been received had the franchise agreement not been terminated. This is often hundreds of thousands of dollars. If the franchisee is terminated for an inability to pay a few thousand dollars in royalty, the franchisor should consider whether asserting that the franchisee owes hundreds of thousands of dollars of additional royalty will simply force the franchisee into bankruptcy.

Which Franchise Agreement Is Terminated?

Prior to termination, franchisors should carefully examine the language of each of the franchisee's agreements. The offending conduct might not be a default under each agreement. For example, an Illinois franchisor was recently unsuccessful in enforcing the post-termination provisions of a franchise agreement after terminating a franchisee for using advertising that was no longer approved by the franchisor because the agreement terminated did not have an express provision allowing disapproval of once-approved advertising. Had the franchisor checked the other agreements of the franchisee, it would have discovered that the agreements included disapproval language and cross-default provisions. In other words, the franchisor used the wrong agreement for its termination.

Check the Disclosure Documents

Perhaps the trap with the biggest consequence is terminating a franchise agreement without knowing that there is or might be a disclosure violation. Such a problem could easily result in a rescission claim even if the statute of limitations has run. If the franchisee files a claim to enforce its rights, the applicable statute of limitations is usually tolled for a counterclaim. Accordingly, franchisors should check and re-check the disclosure documents. If the records are not in order, it may be best to settle the current dispute with a release than to serve a termination notice.

Daniel S. Kaplan is a partner with Kaplan & Greenswag LLC in Northfield, IL. He can be contacted by phone at 847-501-5300 and by e-mail at [email protected].

Often, franchisors assume there is a 'one size fits all' termination notice and that their notice will, in fact, terminate the relationship. All too often, however, a poorly drafted or ill-conceived termination notice provides ammunition for a wrongful termination claim, justification for the unenforceability of post-termination provisions, or even rescission of the franchise agreement. One should always be mindful of the warning 'anything you say can and will be used against you.'

Know the Local Franchise Laws

Perhaps the most common mistake in issuing a termination notice is failure to review local franchise laws. Such franchise laws usually contain anti-waiver provisions that make it unlawful to terminate a franchise agreement without good cause or to fail to give a minimum amount of time to cure. The definition of 'good cause' also varies from state to state. Moreover, if the local law states notice 'in no event need be more than 30 days' as is the case in Illinois, a franchisor would be wise to recognize that if less than 30 days' notice is given, an arbitrator or judge can hold that insufficient notice was given.

The following situation is illustrative of what happens if the local laws are not followed. A motorcycle franchisor believed that one of its Illinois franchisees was harming its reputation and providing unsatisfactory customer service. The franchisor issued a termination notice based on the '30-day no cause language' in the franchise agreement, and it granted a new franchise to another dealer a few blocks away. Unbeknownst to the franchisor, regardless of what is in the franchise agreement, it is unlawful in Illinois to terminate a motor vehicle franchise without giving 60 days' notice. The franchisor also has the burden of establishing 'good cause' for termination. Similarly, it is generally unlawful to place another dealer within 10 miles of an existing dealer without providing 60 days' prior notice and, if the existing franchisee objects, conducting a 'good cause' hearing. Liability to the terminated dealer for not following the local law includes injunctive relief, compensatory damages, treble damages, and attorneys' fees and costs.

Avoid the Laundry List

Another common mistake is to 'over terminate' by including in the termination notice a laundry list of everything that the franchisee did wrong. The risk of using the laundry list occurs because, despite decades of legal precedent, a judge or arbitrator deciding whether a termination is proper will often begin with the 'smell test.' If some of the reasons appear to 'stink,' the judge or arbitrator is more likely to find that the termination was arbitrary. At a minimum, the taint of asserting more obscure grounds raises the probability of increased legal costs associated with defending the termination. It is easy to understand, for example, that a franchisee that has not been paying its required royalty should not be allowed to operate. It is less apparent, however, why a franchisee that used white napkins instead of branded napkins should be terminated.

Make Sure Defaults Are Really Defaults

It also is important that the reasons given for termination are based on actual defaults under the franchise agreement or the operations manuals. Too often, terminations are based on what could be considered subjective impressions that the franchisee is not following an aspect of the system, when, in reality, no such system requirement exists.

If, for example, the franchisee is being terminated for closing the franchised location on Mondays, the franchisor should make certain that the operations manuals state the franchisees must be open on Mondays. Similarly, if termination is based on monetary defaults, franchisors would be wise to check and then re-check the amounts claimed to be owed. If the franchisor miscalculated the amount, or did not provide backup for expenses charged to the franchisee, the franchisee will have ammunition to argue the termination was wrongful.

Spell Out Post-Termination Provisions

Most franchisees do not know what they are required to do upon termination. The termination notice should therefore set forth in plain English a checklist of what the franchisee must do and what will happen if any of the items on the checklist are not done in a timely manner.

It is equally important that the checklist not contain requirements contrary to the post-termination provisions in the franchise agreement. The franchisor also should consider whether to waive some post-termination remedies. For example, many franchise agreements allow for the recovery of the net present value of future royalties that would have been received had the franchise agreement not been terminated. This is often hundreds of thousands of dollars. If the franchisee is terminated for an inability to pay a few thousand dollars in royalty, the franchisor should consider whether asserting that the franchisee owes hundreds of thousands of dollars of additional royalty will simply force the franchisee into bankruptcy.

Which Franchise Agreement Is Terminated?

Prior to termination, franchisors should carefully examine the language of each of the franchisee's agreements. The offending conduct might not be a default under each agreement. For example, an Illinois franchisor was recently unsuccessful in enforcing the post-termination provisions of a franchise agreement after terminating a franchisee for using advertising that was no longer approved by the franchisor because the agreement terminated did not have an express provision allowing disapproval of once-approved advertising. Had the franchisor checked the other agreements of the franchisee, it would have discovered that the agreements included disapproval language and cross-default provisions. In other words, the franchisor used the wrong agreement for its termination.

Check the Disclosure Documents

Perhaps the trap with the biggest consequence is terminating a franchise agreement without knowing that there is or might be a disclosure violation. Such a problem could easily result in a rescission claim even if the statute of limitations has run. If the franchisee files a claim to enforce its rights, the applicable statute of limitations is usually tolled for a counterclaim. Accordingly, franchisors should check and re-check the disclosure documents. If the records are not in order, it may be best to settle the current dispute with a release than to serve a termination notice.

Daniel S. Kaplan is a partner with Kaplan & Greenswag LLC in Northfield, IL. He can be contacted by phone at 847-501-5300 and by e-mail at [email protected].